Homebuilders: Will '07 Be a Rebuilding Year?

A rise in the NAHB index -- and a better than expected profit forecast from Lennar -- offer encouraging signs for the sector

Maybe 2007 won't be such a bad year for homebuilders after all. As industry players fight back against a difficult market, investors appear to be sensing some progress. Case in point: Lennar (LEN) shares climbed Jan. 17 after the company announced that its earnings in 2007 could top those of 2006.

And further serving to buttress investor optimism, the monthly National Assn. of Home Builders survey released Jan. 17 contained more good news. The overall index rose to a higher than expected 35 level in January from 33 in December, which was revised upward from 32. The main source of strength was in the single family component of the survey, which climbed to 36 from 33. Also, the buyer traffic index rose to 26 from 23.

The January NAHB data "add to the evidence the worst of the housing slump may be behind us" according to Standard & Poor's MarketScope.

As demand for housing has cooled in recent months, Lennar has been cutting its land inventory and he's also building fewer homes. Now its plans for 2007 include cutting selling, general and administrative expenses and construction costs, along with redesigning its products and building to meet the current market demand. Lennar CEO Stuart Miller expects to deliver more than 20% fewer homes in 2007 compared to 2006.

"As we look ahead to 2007, the strength of our balance sheet, together with our renegotiated land positions that reflect current market conditions, provide the springboard from which we will rebuild our margins," Miller said in a press release Jan. 17. The amount of profit he made on home sales excluding inventory valuation adjustments had amounted to 14.4% during the fourth quarter, sharply lower than 27% during the same period of 2005.

Miller isn't expecting a turnaround overnight. Lennar still has around $4 billion of unfulfilled orders, which is down 42% compared to last year, and the CEO says that will result in his company's having lower profitability in the first half of 2007. On a brighter note, if the current environment of strong employment, low interest rates and a healthy economy continues, and the new home market shows its usual seasonal improvement, Miller is betting that his company will exceed its 2006 earnings of $3.69 per share in the current year.

Comparisons might soon be easier than they were in 2006. Miller posted a loss of $195.6 million during the fourth quarter, compared to earnings of $581.2 million during the same period last year. "As we noted in our pre-earnings release, market conditions have remained depressed through the end of our fourth quarter," Miller said in a press release Jan. 17.

This comes even after Miller had warned investors on Jan. 2 to brace themselves for losses between 8 cents per share to $1.28 per share during the quarter, after taking adjustments and write-offs for things such as inventory and land-related losses (see BusinessWeek.com, 1/2/07, "A Nasty Hangover for Homebuilders"). On Jan. 17, the company announced a loss of $1.24 per diluted share.

Lennar posted $4 billion in home sales in the fourth quarter of 2006, down 14% from a year earlier. Selling, general and administrative expenses as a percentage of revenues from home sales increased to 12.1% in the fourth quarter of 2006, from 9.8% in 2005. Loss on land sales totaled $119.9 million in the fourth quarter of 2006, compared to profit of $58.2 million in 2005.

Even as interest rates began to rise a couple years ago, many homebuilders kept borrowing at a frenzied pace and burning through their cash. But Lennar unloaded its properties early as demand for housing cooled. During the quarter that ended Aug. 31, 2004, for example, Lennar generated roughly a quarter of his $225 million in earnings from land sales to other builders. By contrast, Lennar's land sales had contributed less than $2 million to its bottom line as recently as 2001 and 2002.

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